German central bank criticizes promissory note deal

“But on Ireland, let me say this: there was not a decision to take. The Governing Council unanimously took note of the Irish operation and I am going to refer you to the Irish government and the Irish central bank for the details of this operation, which was designed and undertaken by the Irish government and the Irish central bank. I can only say today that we took note of this. We all took note of this.” ECB president Mario Draghiin response to the question “There have been reports in the media in the past hour that the ECB has reached a deal on Anglo Irish Bank and I was wondering whether you could confirm that and whether you could provide us with details of the agreement?” on 7th February 2013

Well, there’s one key difference between the websites of the Central Bank of Ireland and the German central bank, the Bundesbank – on the German bank’s website, there’s a shopping cart because they expect you to pay for some reports. Remember these are the people from whom we expected a debt write-down.

One report which is free is a report today which provides an overview of the German economy. Thankfully there is an English version available here. The media is focusing on comments on the promissory note deal announced a fortnight ago, and this is what the Bundesbank has to say on the subject.

“At its latest meeting, the ECB Governing Council took note of the remarks by the Governor of the Central Bank of Ireland regarding the treatment of the state-owned Irish Bank Resolution Corporation (IBRC), which the Irish government had liquidated shortly beforehand. The Irish central bank had granted emergency liquidity assistance to IBRC and, following its liquidation, assumed full ownership of the relevant collateral. Among other things, the Irish government and central bank subsequently agreed that the Irish government’s promissory notes which formed part of the collateral would be exchanged for longer-term Irish government bonds with lower coupons. The Irish central bank ultimately pays interest on the new bonds to the rest of the Eurosystem at the main refinancing rate, while the Irish government’s interest payments are collected as net income by the Irish central bank and can be used for distributions to the government at a later date. This approach underlines the increasingly close and problematic ties between monetary and fiscal policy in the European monetary union. Responsibility for providing any assistance to individual member states in servicing their sovereign debts should lie with the European Stability Mechanism (ESM), which was established for this purpose”

What is worrying is that the Germans are members of the ECB Governing Council – see full list of members here – and as the ECB “unanimously took note” of the promissory note arrangement, there might be concern that “problematic ties between monetary and fiscal policy” mean there is pressure on the Irish government to dispose of the bonds used to swap with the promissory notes, on the open market sooner rather than later. Remember under the present arrangement, Ireland is paying a paltry 0.75% on the bonds used to swap with the promissory notes. But if €25bn of 2040 and 2053 bonds hit the sovereign bond markets tomorrow, the likelihood is that we would be paying 4%.

It seems however that there is no cast iron guarantee that Ireland can keep the bonds at the Central Bank at its discretion. In response to parliamentary questions from Sinn Fein and Fianna Fail last week, the Minister for Finance Michael Noonan used the same wording “The bonds will be placed in the Central Bank’s trading portfolio and sold as soon as possible, provided that conditions of financial stability permit. The disposal strategy will maintain full compliance with the Treaty prohibition on monetary financing.”

We have no idea what Minister Noonan means by “financial stability” and the Bundesbank might have a different view to our own. So we might come under pressure to take the bonds out of the Central Bank sooner rather than later. If that happens then the NPV of the deal could dramatically fall from €6bn.